Delta’s plot for refinery success: Planes, Trainer and Automobiles

In the movie Planes, Trains and Automobiles, Steve Martin and John Candy have problems with every one of those modes of transportation on their journey home. Delta Air Lines ponders a similar plotline with its newly purchased refinery.

Of course, there are planes involved. But the longer journey to success also relies on railroads hauling cheap crude to the refinery and renewed driving demand to help gasoline margins.

Delta last year made quite a dramatic departure for an airline. It bought the Trainer, Pennsylvania, refinery in May for $150 million from Phillips 66. It was the first time an airline has ever bought a refinery. Delta said it paid about the price of a new plane. I said on Platts Energy Week that it wasn’t exactly like buying a Dreamliner, although perhaps that analogy is fitting after all given that new plane’s own problems.

But unlike the Dreamliner, a big new US refinery hasn’t been built since the mid-70s. They need lots of maintenance, are prone to break down and are under heavy regulation. There’s a reason traditional refiners are eager to sell.

Delta restarted the idled refinery in September and got kudos for keeping it running through Hurricane Sandy. But Delta reported earnings today and said it lost $63 million at the 185,000 b/d refinery largely on a slowdown from the storm, which damaged regional pipelines and terminals and reduced distribution points.

In late December, Delta shut a fluid catalytic cracker. Sources said the unit ran at an excessively low rate for too long, letting the damage build. In the earnings call, Delta said it had to take the unit offline because of slowdowns from the storm but said it would return online by the end of January. Sources said February or March is more likely.

Their VP of Fuel, Jon Ruggles, also left suddenly. He was a key architect of the refinery purchase and the creation of a trading arm around it.

And jet fuel isn’t a big part of what refineries spit out. There’s a good chance Delta is selling gasoline and fuel oil at a loss and that’s more than half their production. New York CBOB gasoline was assessed at $116.87/barrel on January 18. Dated Brent crude was $111.85/barrel that day. On a December investor call, executives said Delta relies on even more expensive crudes,cost saying they about $4/b above Brent. Fuel oil, meanwhile, is definitely selling at a loss, at less than $100/bFuel oil, meanwhile, is definitely selling at a loss, at less than $100/b. (Please see correction below)

Delta points out they have an experienced management team at the refinery; It created Monroe Energy to run the plant. To be fair, other US refineries have bigger problems: Shell has found issue after issue in a huge expansion at the Motiva Port Arthur refinery, a joint venture with Saudi Aramco in Texas. Chevron has been at half-production since a crude unit fire in August at Richmond near San Francisco. This is just one unit at Delta and these problems work their way out.

But for a longer-term picture, critics say Delta is chasing after a three-legged ballerina, as Candy says in the movie.

Delta wants jet fuel to be one-third of their production, and said in December it had reached 20%. Many people say they’ll be lucky to get beyond 20%.

Delta wants to rail in very cheap crude oil from North Dakota, which would be a heavy investment, even if they could find the railroad cars needed. Platts reported that Delta said in its earnings call it would receive its first railroad shipment of Bakken crude this quarter in a test run.

And Delta just can’t avoid making gasoline, which many people think is going to suffer from poor margins for a long time.

But jet fuel prices have skyrocketed to a third of airline costs. Delta thinks it can save about $300 million a year by making its own fuel, and isn’t changing that tune. “Since we’ve actually closed on the refinery and spent a lot of time in the turnaround process, we’ve become more certain of how prudent that investment is for our company,” Delta CEO Richard Anderson said in the earnings call.

Many sources still say Delta is going the wrong way by operating a low margin-high risk refining business. Yet Delta has done the most out-of-the-box thinking in trying to control fuel costs, to the point where it could borrow a famous retort by John Candy in the movie: “How would he know which way we’re going?”

(Note: this blog entrywas corrected to note that the comments about more expensive crude came from a December investor call, not today’s earnings call.)

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Comments

Don Schroeder at July 26, 2014 8:37 pm

When oil refiner’s start buying airlines as an outlet for distillates we will truly know the world has been turned upside down. I suspect that Delta’s next move will be to start building airplanes since they cost more than a refinery!

Thanks Jim. Many people would point out Delta has mostly lost money on the refinery since the purchase, although it reported a slim $13 million refinery profit in Q2 2014 this week. But they may be benefiting in other ways, such as knowledge that cascades into what many say has been a successful hedging program. Also worth noting is that Delta has generally reported lower fuel costs than competitors, including an average of $2.92/gal in the second quarter.

If Delta can save significant dollars on their fuel costs, they can afford to run this refinery at a loss. If the refinery is in fairly good shape w/o the need for major revamp or addition of expensive pollution-controls, they’ve made a smart move.